By Nilanjan Banik and Guido Cozzi
By the end of this century, planet earth may not be a liveable place, with the average temperature rising at least 2.5 Celsius higher than what it is now. This is according to the latest published UN Climate Change Report. With the climate change set to become worse, the world which is already experiencing a regular bout of deadly heat waves, floods and drought, hurricanes, may have to brace for potentially irreversible natural calamities, impacting the lives of at least 3.3 billion people. And all of these have to do with the dependence on fossil fuel and the resultant greenhouse emissions. In fact, there is another darker side. Control over fossil fuel is a reason for major wars, with a negative spill-over effect on the economies.
But why war? World energy depends on geographically localized resources, with large quantities of fossil fuels concentrated in tiny areas of the planet. Hence, control over the coal, oil, and natural gas regions is highly valued. The bordering countries try all excuses – different religions, languages, alliances, etc., to grab them. Conflicts suddenly start as soon there is a temporary change in balance of power, breaking the previous peace deal.
History has shown time and again control over fossil fuel has been a reason for some of the biggest wars. Consider this. Next year is the centennial of the occupation of the Ruhr (1923-1925). The Ruhr region spreads around the Rhine River, which borders France and Germany. The French and Belgian troops occupied the mineral and industrially rich Ruhr region, as Germany was not sending coal to France as part of the reparation deal struck during World War I. This occupation led to the crash of the German currency and the economy, which eventually led to the start of World War II.
Almost 45 years after the end of World War II, ownership of fossil fuel (petroleum) became the focus of another global conflict when Saddam Hussein invaded the neighbouring Kuwait. A win over Kuwait would have made Iraq world’s leading energy power, dominating both the Arab and the Persian Gulf regions, home to the bulk of the planet’s oil reserves. The US and its allies could not accept this dramatic shift in balance of power if Iraq were let to win.
Fast forward to the present day conflict involving Russia and Ukraine. The Donbas region has a rich coal reserve. The other parts including the Dnieper-Donetsk region, and the Black Sea of Azov is a rich source of natural gas, an important input for manufacturing fertilizers. Earlier during 2014, Russian invasion of Crimea is related to control over oil and natural gas reserves in the Black Sea region. Like the Ruhr region which had a considerable German population but was occupied by the French and Belgian, this time around the Donbas, Dnieper, Donetsk and the Luhansk regions had a considerable number of Russian speaking population; with both the parties claiming the territories.
What is worrisome, the apparent randomness of these conflicts and their duration had led to a highly volatile energy price and its resultant negative impact on the economy. Take for instance, the Yom-Kippur war of 1973 and the subsequent Saudi embargo, leading to worldwide stagflation. During 1974, to fight the raging inflation that skyrocketed to 11%, the then FED chairman, Arthur Burns raised the funds rate to 12%, before reducing it back to about 5% in 1975. But that did not help as there was a second oil crisis in 1979 with the start of the Iran-Iraq war. To tame the inflation, Paul Volcker, who was in charge of the FED, pursued a consistent hawkish policy. Between 1979 and 1981, the FED increased policy rates from 13.6% to 20%. It took about a decade to tame inflation reaching 14.5% in the US during the early part of 1980s.
However, such monetary tightening came with a cost of recession (famously touted as Volcker’s recession), with the US unemployment rate climbing to a 10%. There was other collateral damage. Countries like Argentina, Brazil, and Mexico which borrowed heavily in dollars to sustain infrastructure investment defaulted as an appreciating dollar increased the cost of borrowing.
One can notice some eerie similarity with the current set of events. Many countries in Asia (Pakistan and Sri Lanka), Europe (UK) and in Latin America (Argentina) are suffering because of an appreciating dollar, an outcome of a hawkish monetary policy undertaken by the FED Chairman Jay Powell.
The 2022 inflation is not as bad as what the US witnessed during the late 1970s, but it is the worst inflation in decades. A more aggressive monetary tightening, with the Fed increasing the policy rate by 300 basis points since March 2022, has led to an increase in the yield on one-year US treasury security. Yield on the US treasury increased from 1.86% in 1 March 2022 to 4.80% on 4 November 2022. More such bouts of quantitative tightening may follow, and that may spell bad news for emerging and developing economies. The good news, however, as during the 70s, central banks around the world, are now reluctant to raise rates on par with inflation, possibly leaving inflation the time to spread and engrain into expectations and wage contracts.
The inflation volatility is the outcome of our excessive dependence on fossil fuels, and so as are many conflicts, dictatorships, and climate change. An uncertain economic environment instigates fear and induces high defence spending that could otherwise be spent on social welfare measures and to arrest a degrading environment. A move towards renewable energy may come as a saviour. Unlike fossil fuels, sources of green energy – sunlight, water, wind – are much less localized, and that would eliminate the reason for many territorial conflicts. (IPA Service)
** Nilanjan Banik is with School of Management, Mahindra University
** Guido Cozzi is with Institute of Economics, University of St. Gallen